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Good morning. My name is Lindsay, and I will be your conference operator today. At this time, I would like to welcome everyone to the Spin Master Second Quarter 2018 Financial Results Conference Call. [Operator Instructions] You may begin your conference.
Thank you, Lindsay. Good morning, everyone, and welcome to Spin Master's Financial Results Conference Call for the second quarter ended June 30, 2018. My name is Karoline Hunter, and I'm Spin Master's Senior Director of Investor Relations. I'm joined this morning by Ronnen Harary, Co-Chief Executive Officer; Ben Gadbois, Global President and Chief Operating Officer; and Mark Segal, Chief Financial Officer.Following our formal remarks, we will open up the line for your questions. For your convenience the press release, MD&A and audited consolidated financial statements for the second quarter are available on the Investor Relations section of the company's website at www.spinmaster.com as well as on SEDAR.Before we start, please note that remarks on this conference call may contain forward-looking statements about Spin Master's current and future plans, expectations, intentions, results, levels of activity, performance, goals or achievements or any other future events or developments. Forward-looking statements are based on information currently available to management and on estimates and assumptions made based on factors that management believes are appropriate and reasonable in the circumstances. However, there can be no assurance that such estimates and assumptions will prove to be correct. Many factors could cause actual results to differ materially from those expressed or implied by the forward-looking statements. As a result, Spin Master cannot guarantee that any forward-looking statements will materialize, and you are cautioned not to place undue reliance on these forward-looking statements.Except as may be required by law, Spin Master has no obligation to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. For additional information on these assumptions and risks, please consult the cautionary statement regarding forward-looking information contained in the company's earnings release dated August 1, 2018.Please note that Spin Master reports in U.S. dollars, and all dollar amounts to be expressed today are in U.S. currency.I would now like to turn the conference over to Ronnen Harary.
Thank you, Karoline. Good morning, and thank you for your interest in Spin Master. Yesterday, we reported our financial results for the 3 and 6 months ended June 30, 2018. I'd like to start with some highlights for the quarter as well as the year ahead before Mark provides you with more detailed review of our financial results, including our outlook for the balance of the year. Ben will then discuss Spin Master's operational results and our execution against our core growth strategies.As everybody is aware, after years of financial struggles caused by unsustainable debt burden, Toys"R"Us finally closed the stores in the United States at the end of June. We don't believe that the demise of Toys"R"Us is an indication of the fundamental health of the toy industry. According to Euromonitor, the industry has been steadily growing globally at just under 5% per year for the past 6 years, and according to Euromonitor, global industry growth is said to be 70 -- 7% for 2018 and 4% for 2019. TRU was a global business, and many of TRU's operations around the world have been sold or are in the process of being sold, and will continue to operate. While the liquidation sales in the U.S. did have a negative effect on our results this quarter, we're confident in the resilience of the industry and our growth strategies.As we have mentioned previously, there are still some -- still same number of kids out there celebrating birthdays and holidays will come around every single year. One of our core strategies is to create evergreen TV and short-form content that maximizes our franchises' values. Since 2008, we've been creating content that has delivered exceptional results. Kids today are multi -- are media multitasking, simultaneously accessing different sources of media, including TV, the web, digital apps, radio, phone and print. Kids can juggle these various media forms because they are digital natives. They've been born into and have grown up in the digital age. We are very focused on reaching and interacting with kids wherever they played to ensure that our products and content remain relevant in their eyes.The demand for PAW Patrol continues to be strong. The show is televised an average of 6 times more frequently than any other preschool show in Nickelodeon. Season 5 is currently running in North America. The first half of Season 5 was a continuation of Sea Patrol theme that we first introduced in September 2017. We just launched the second half of Season 5 on Nickelodeon with the Ultimate Rescue theme. The pups will be leaping into each other's supersized rescue team vehicles for exciting ultimate teamwork rescue missions. The first episode, Ultimate Chase, aired on June 22, and the rating for the episodes were the strongest the show has ever received -- sorry, the show is the strongest -- the rating was the strongest for 2018. I also encourage everybody to watch the show. We're continuing to invest in PAW Patrol franchise, with 52 creative new episodes every single year.We're also launching exclusive direct video content and toys at Walmart in September. Mighty Pups, a 44-minute special will be released in DVD before it premieres on Nickelodeon this fall. The special is also sneak peeked into our theme for Season 6. We plan on more of these exclusive DVD and TV -- and toy launches in the future. We're also hard at work on planning for the PAW Patrol movie.Our second preschool TV show currently on air is Rusty Rivets, and the rating for the show continue to be strong. According to Nielsen, Rusty Rivets is ranked in the #3 spot for boys ages 2 to 5. In Season 2, Rusty and Ruby used their knowledge of engineering to repurpose machine parts, to build new creatures, including Botarilla, Tigerbot and Elephantbots. We found kids really gravitated to the Botasaur creature we introduced in Season 1. We are now in development for Season 3 together with Nickelodeon. The Rusty Rivets toy line is launching globally this month and is tied closely with the building theme prominent in the show.As I mentioned in May, we're hard at work on the second new -- on 2 new shows we'll be releasing in 2019: the preschool property, Abby Hatcher: Fuzzly Catcher, airing on Nickelodeon in late 2019; and the relaunch of our Boys Action property, Bakugan, airing in spring 2019. We're aggressively planning for these entertainment and toy launches and are already starting work for Season 2 on Bakugan. Both franchises have innovative and imaginative toys that we think will resonate very well with kids.Moving to the Hatchimals franchise, which is continuing to build momentum. We're innovating the large eggs to ensure that we continue to deliver the magical surprise that the original higher-price-point egg was based on. At the same time, we're developing new themes for the lower-price-point collectible line. The entertainment team is highly engaged in producing short-form, character-based, story-based content for the Hatchimals franchise. We are also fortunate to have such a talented team in-house to bring these characters to life in innovative and creative ways. This will lay the foundation to build a long-term franchise. We are very excited about the in-house licensing capabilities we are now developing. Our first major internally managed licensing-out program is for Hatchimals, and the licensed merchandise is doing well across a broad range of merchandise categories. We are continuing to add new categories both domestically and internationally, and these capabilities that we are now building in this area will provide the foundation for other franchises over time.Our mobile strategy plays into the media multitasking that I referred to earlier. Toca Boca and Sago Mini now have over 70 apps between them and continue to grow. Currently, 9 out of top 10 paid apps for kids are Toca Boca apps. We're also focusing on B2B and, in Q2, we rolled out a program with Singapore Airlines and American Airlines whereby select Toca Boca apps are available on in-flight entertainment systems. We're looking at a wide range of additional opportunities to introduce kids to our apps and tie them to our innovation-led toy development capabilities.I want to conclude with a point on the momentum we are seeing in the Activities, Games & Puzzles area. Ben will talk more about this later, but I want to call out how exciting it is to see these segments of business that we have nurtured for some time now start to grow. Across the business, we have an innovative and dynamic fall product line, and we look forward to executing well against our key growth strategies to deliver an amazing experience for our customers.Now I'll hand over to Mark Segal, our Chief Financial Officer, to review our financial results in more detail. Mark?
Thanks, Ronnen. We are pleased with our financial performance in what was a challenging quarter for the industry. Overall, our second quarter revenue increased by 12.6% to $311.5 million from $276.7 million in 2017. Most of our key competitors suffered revenue declines in the quarter, so this is a very good result. FX tailwinds increased overall revenue by $2.4 million. In constant currency terms, revenue increased by 11.8%. Gross product sales increased 4.6% for the quarter.On a geographic basis, one of our global platform drove gross product sales growth in North America and very strong growth of over 25% in the rest of the world. Europe showed a 7% decline in shipments. The U.K. and France are Europe's 2 largest toy markets. In March and April, Toys"R"Us U.K. was liquidated, and in early July, TRU France went into receivership, but it's still operating. The U.K. liquidation and the uncertainty in France, in Q2, created a climate of caution in those markets and in some other European markets. This cautionary climate resulted in an overall reduction in orders and shipments in the second quarter. Despite this, certain markets in Europe, such as Germany and Central Eastern Europe, continue to show strong performance. We are now seeing a return to normal purchasing behavior in Europe as the cautionary climate dissipates and these markets stabilize. Overall, international gross product sales as a percentage of total gross product sales continues to grow. International gross product sales comprised 32% in the second quarter, increasing from 30.9% last year, and continuing the steady progress we have made over the last few years.The liquidation of Toys"R"Us' U.S. business, more than 700 stores, was completed during the second quarter. This had an impact on our sales volume and gross margin, as TRU did not replenish its sold inventory in these stores nor did TRU forward buy the initial FOB purchases towards full sets as they normally would late in Q2. For perspective, in Q2 '17, we shipped approximately $25 million to Toys"R"Us in the U.S. In general, the TRU liquidation went as we expected, with the majority of the inventory sold through by the end of June. Outside of the U.S., Smyths Toys agreed to purchase TRU in Germany, Austria and Switzerland. Fairfax announced the acquisition of Toys"R"Us' Canadian operations and agreed to repay or pay indebtedness [ owing ]. Toys"R"Us Australia announced it was closing its 44 stores, and following the end of Q2, TRU France announced it will enter receivership. We continue to supply France but on a prepaid basis. We have managed credit in both those countries very tightly, and we do not have any material credit exposure in either France or Australia or any other TRU entity for that matter.On our last earnings call, we discussed how the timing of Easter this year affected both comparisons for Q1 and Q2 against 2017's results. As a reminder, in 2017, Easter occurred in the middle of April, which fell in Q2. This year, Easter fell on April 1, resulting in Easter sales volume falling into Q1. If you look at sales H1 '18 versus H1 '17, gross product sales for the half year were up 14.1%, which is a very strong performance, taking everything into account. Sales allowances, as a percentage of gross product sales, was 6% for the quarter. This is well below our annual sales allowance range of 10% to 12%. The decrease is attributable to the timing of promotional and markdown spending, some closeout activity in the quarter and our continued tight focus on the management of allowances in general. Other revenue, which primarily reflects merchandising royalty and television distribution income from products marketed by third parties using our intellectual property as well as app revenue from Toca Boca and Sago Mini, continues to grow and increased by over 88% for the quarter. As Ronnen mentioned, we are seeing the results of the strong licensing and distribution programs associated with our brands and entertainment franchises. And entertainment with our mobile digital apps is growing.Our gross margin for the quarter decreased by 1.9%. This margin erosion was mainly attributable to the amortization associated with the delivery of more entertainment episodes compared to last year without their full revenue being reflected and closeout sales of certain discontinued lines during the quarter. The decrease was partially offset by higher other revenue and lower sales allowances.Total SG&A, excluding share-based comp arising from the equity participation awards at the time of the IPO, increased 1.9% as a percentage of revenue. The largest drivers of this increase were higher marketing and admin expenses. Regarding marketing, spending for the quarter was 8.5% of revenue, up from 7.4% last year. The media landscape is evolving, and we are at the forefront of this. Marketing initiatives for the quarter included traditional media, trade shows and content and merchandising initiatives. In line with the changes in the way kids consume content, we've been allocating a greater proportion of our marketing spend towards digital and social media. Several unique spring product launches affected our total marketing costs during the quarter, including marketing for the new seasons of Colleggtibles, Party Popteenies and Flush Force as well as increased support for Hatchimals and PAW Patrol. We delayed the new PAW Patrol Ultimate Rescue theme until closer to the key selling period in Q3, and we used marketing as a replacement for that new TV content. Product development expenses were slightly higher than last year as a result of the timing of our development programs within the 36-month brand innovation pipeline. Selling expenses and distribution expenses decreased as a percentage of revenue compared to Q2 last year. In the case of selling expenses, third-party licensed products continue to make up a lower proportion of our sales mix, accounting for the decrease. We are also seeing the benefits of investments we previously made to our supply chain infrastructures to support our domestic business in Europe, growth in Cardinal and our overall growth.Admin expenses in Q2, as a percentage of revenue, increased 60 basis points from last year. The increase is primarily attributable to people cost associated with our recent acquisition of Gund, the mark-to-market of our LTIP, which resulted in a $4.6 million charge compared to 0 in Q2 last year, and additional resources to support our international expansion, which has a very high ROI. The mark-to-market of the LTIP is not added back to adjusted EBITDA, and going forward, we intend to change the LTIP structure from cash to equity settlement to avoid this P&L volatility. The increase in admin expenses was partially offset by a continued focus on cost control in all other areas of G&A and lower IPO-related share-based comp costs.Net income increased 21.7% year-over-year. Part of the increase was due to a $15.5 million legal settlement in our favor relating to a long outstanding claim. We can't get into the details, but we are very pleased to have successfully concluded this case. We will receive the $15.5 million cash during this year. Given the nature of the claim, we have not included it in adjusted EBITDA. On this basis, adjusted net income decreased 24% -- 20.4% from Q2 last year. Adjusted EBITDA for the quarter increased 3.8% to $45.4 million compared to $43.7 million last year. We are very pleased to show adjusted EBITDA growth for the quarter despite the many headwinds we faced. Adjusted EBITDA margin decreased by 1.2% mostly due to the increase in SG&A. However, as I mentioned earlier, the nature of the SG&A increase is such that we expect these investments to have a strong ROI with later -- in later quarters or, in the case of the LTIP mark-to-market, to no longer be a factor.Looking at our business segments for Q2. In the Activities, Games, Puzzles and Fun Furniture segment, gross product sales maintained a strong positive momentum primarily due to increased sales of Games and Puzzles, which includes Cardinal, the Cool Maker-branded products and Kinetic Sand, offsetting decline in Bunchems and Build-A-Bear. Gund gross product sales in the quarter were approximately $10 million. In the Remote Control and Interactive Characters segment, Hatchimals Colleggtibles and Luvabella are driving growth. However, sales of the higher-price-point Hatchimals eggs have declined as have sales for Zoomer and Air Hogs. If you recall, the large egg in the first half of 2017 generated significant sales due to pent-up demand from its launch in Q4 '16. For this reason, we always expected H1 '18 to be a difficult comp for the large egg. Overall, the Hatchimals brand continues to show strength driven by Colleggtibles, and we continue to innovate and develop the brand. Gross product sales in the Boys Action and High-Tech Construction segment increased in the quarter as a result of sales of Tech Deck on the back of a resurgence in the skateboard market in advance of the 2020 Tokyo Olympics in which skateboarding is now an official sport for the first time. Initial selling of Boxer and sales of discontinued Star Wars licensed products also contributed to growth, partially offset by declines in Meccano and Pirates of the Caribbean licensed products. In the Pre-School and Girls segment, new product launches of Party Popteenies, Twisty Petz and Rusty Rivets growth -- drove growth, but this one was more than offset by a decline in sales of ZhuZhu Pets, Chubby Puppies as well as PAW Patrol. PAW Patrol is obviously an important discussion point. Global POS for PAW Patrol for the quarter was positive, and our retail inventory position is very tight, but the TRU liquidation had a negative effect on PAW Patrol in the U.S. for the quarter. Ben will provide more details on this later in the call.In the Outdoor segment, gross product sales decreased marginally in the quarter as Swimways was disproportionately affected by the TRU U.S. liquidation, which occurred during their largest seasonal selling season in H1. Despite this, Outdoor was still up for H1.Our balance sheet remains very strong. Net working capital, as a percentage of revenue, decreased by 1.2 percentage points to 9.6% of LTM revenue. This was due to improvements in all areas of working capital management in both our core and acquired businesses. Our cash conversion cycle decreased by nearly 9 days in the quarter. Free cash flow, while still positive, was lower this quarter compared to last year. The decline in free cash flow is attributable to lower cash flow from operating activities and nonrecurring CapEx related to our new corporate office build-out in Toronto. Given the TRU liquidation and the timing of Easter, I wanted to share a few important points for H1, as when you have material events in a quarter such as those we just described, it's also important to stand back and review a fuller period which is more reflective of performance. As I mentioned earlier, for H1, revenue was up 18% and gross product sales were up over 14%. Europe is up nearly 14% for H1 with very strong sales contribution from some of our key European territories, such as Germany, the U.K. and CEE. The rest of the world is up over 35% based on strength in Mexico and Australia. Activities, Games & Puzzles; Radio Control and Interactive Characters (sic) [ Remote Control and Interactive Characters ]; Boys Action and High-Tech Construction as well as Outdoor are all meaningfully up for the half year. Pre-School and Girls is marginally down, but this is largely due to the decline in licensed product and the impact of TRU. As you will hear later from Ben, we remain positive about PAW Patrol for the balance of 2018 as well as some of our newly launched owned IP brands. Overall, global POS is up 20% for H1, and retail inventory is down over 25%. This sets us up well for the second half of the year. Despite the decline in Q2 from the U.S. TRU liquidation, the increase in amortization from higher TV show deliveries and the cleanup of some of our discontinued inventory, our gross margin for H1 is marginally up over '17. As we refine our brand innovation process, we accelerated our content production timing and influence on marketing investments in H1, which will drive benefits in H2. Our marketing spend overall remains well within our historical spend levels of approximately 10% of sales. SG&A for H1, excluding the TRU bad debt in Q1 and equity participation awards at the time of the IPO, is up 90 basis points over '17. But this is mainly driven by higher marketing costs from some investment spending with a strong ROI such as the Gund acquisition and international expansion and the mark-to-market of our LTIP, which I referred to earlier. If the mark-to-market of the LTIP is excluded, SG&A is flat H1 '18 versus '17. All other areas of SG&A such as selling, warehousing and distribution and nonpayroll admin costs are down as a percentage of revenue. Cost control and productivity programs remain a key area of management focus globally. Adjusted EBITDA is up 18.9% for H1, nearly 5% higher than our gross product sales growth rate. And despite the disruption of TRU, we held our adjusted EBITDA margin flat with 2017 at 14.8%. If the mark-to-market of the LTIP is excluded year-to-date, adjusted EBITDA margin is 80 basis points higher in '18 versus '17.On April 2, we closed the Gund acquisition on terms in line with what I described in May. Also, on July 10, 2018, we amended our U.S. $510 million credit facility to take advantage of the improved pricing environment and to accommodate our growth plans. The maturity date has been extended by 18 months to June 2023. This gives us more flexibility to continue to execute our organic and acquisition-driven growth strategy. I will conclude with our outlook for 2018. For the full year 2018, organic gross product sales are expected to be in line with prior guidance, which is for mid-single-digit organic growth compared to '17. Including Gund, gross product sales are expected to be in line with prior guidance, which is for mid- to high single-digit growth compared to '17. This growth outlook is in line with our long-term growth target of mid- to high single digits. We are seeing signs of stabilization in the industry following Toys"R"Us' demise. While we have kept our sales guidance consistent with our prior outlook, we are hopeful that the industry will recover faster than we expected and now our customers will be able to recapture more of TRU's volume than we expected. We have positioned ourselves through our tightened focused inventory management to capture this potential recovery. Ben will talk about this more in a minute. Turning to our outlook for profitability. We expect adjusted EBITDA margins in '18 to be slightly higher than those we achieved in '17. We are extremely focused on cost management and productivity and expect that we will be generating further operating leverage in the second half of the year. Combined with the product mix, which contains more owned IP products, this will lead to a slightly higher -- this will lead to slightly higher adjusted EBITDA margins overall for '18. As a reminder, please note that adjusted EBITDA margin is calculated on revenue and not gross product sales.I'd now like to turn it over to Ben Gadbois. Ben?
Thank you, Mark. We're pleased with our financial and operating results in the second quarter of 2018. Our solid performance is grounded in clearly defined growth strategies that continue to work well. As expected, the U.S. liquidation of TRU dominated the quarter. This liquidation sale discount drove consumers to Toys"R"Us who did not replenish their shelves, and consequently, we saw decreased activities at other retailers. Despite this, we still grew gross product sales over 14% for the first half of the year. We think this is an incredible achievement and showed a strength of Spin Master's brand and franchises. But based on the TRU U.K. liquidation results, it appeared that most liquidation purchases made were for immediate consumption. We believe this is consistent with what will happen in the U.S., and that 80%, 90% of Toys"R"Us volume will be redistributed in the second half of '18. The battle for market share continues with retailers aggressively looking for a greater share of the market previously held by TRU. We are seeing the retailers considering out-of-aisle option or borrowing space from other departments to accommodate the extra inventory. At the end of the day, however, the market is divided. We are agnostic as to where the consumer want to shop. Our goal is to give end consumers the best experience we can in the channel of their choice. We closely monitor POS and supply and demand because they are not only an important metrics of brand health but also critical to managing the company and our balance sheet. We rigorously measure beginning inventory, shipment in, POS and ending inventory. In H1, our global and U.S. POS growth was over 20%, yet at the same, retail inventory level declined by over 25%. The growth in POS, coupled with a decline in channel inventory, indicates that our focus on managing the right balance at retail is working. But this was not an easy result to achieve given the TRU liquidation.As Mark mentioned earlier, we saw a decline in PAW Patrol shipment in the second quarter. This was fully expected as PAW Patrol comprises significant proportion of TRU's inventory. The PAW Patrol has a dominant leadership position in the preschool category and was the largest dollar position held by TRU when they entered liquidation. This resulted in actual PAW Patrol POS growth at TRU, but it declined the POS at other retailers and drove shipment decrease of PAW Patrol at retail overall. However, despite the decline in Q2 shipment, the global PAW Patrol grew for the first half of 2018. We carefully manage inventory of retail to ensure strong new product merchandising on shelves for fall 2018. As we get deeper into the second half of 2018, our remaining retail customer base is well positioned to capture most of the lower volume at PAW Patrol in Q2. We are seeing this already in early POS reads following the quarter where we have seen the current PAW Patrol POS growth is now back at the same level we observed in 2017, indicating that the TRU liquidation has not had a permanent effect on current purchases. Overall, we are pleased with our inventory position at retail going into Q2 -- into Q3 as this sets us up for a strong second half of the year. The shift to online sales continue, and in the wake of TRU, we believe this trend is growing quickly.Some long-term forecast indicates that online should and could reach 50% of toy sales in the next 5 years. In 2017, online represented 27% of all toy sales globally according to NPD. We are roughly in line with this percentage. Our e-commerce growth continues to outpace additional retail growth. For the year-to-date, our U.S. e-commerce POS was up low double digits compared to last year. As more of our consumers move online, we believe we are well mobilized to capture the e-commerce momentum.I'd now like to briefly review our 4 key growth strategy -- strategies and provide you with an update on some of our current initiatives. Our first growth strategy is to continue to innovate the core product line. We are hard at work across all our business segments using our rolling 36-months brand innovation process. We expect to deliver some exciting and disruptive innovation over the next few years. Our product line in 2018 is strong across all our business segments. In the Activities, Games, Puzzles and Fun Furniture category, we continue to have high double-digit growth. Cardinal, in particular, is doing very well, and we are excited about its global potential. We are excited about this segment generally as Games and Puzzles deliver stable recurring revenue. Kinetic Sand is showing a very strong resurgence, and we have established a long-term position for Kinetic Sand in the compound category.We are very excited about the innovation we have brought to the classic play pattern of making friendship bracelet with the KumiKreator braided bracelet maker and have high expectation for this item this fall. In Remote Control and Interactive Characters, we continue to grow Hatchimals, expanding in both size and scope with innovation in the big egg, the introduction of additional series of Colleggtibles, short-form content for YouTube and a diverse licensing and merchandising portfolio. We will be launching a new innovative Hatchimal product on our third global Hatchimal Day on October 5, 2018. We also expanded our short-form content, launching the live unboxing series called Hatch Club on YouTube, and we are also seeing some great innovation in the pipeline for 2019 and beyond.Moonlite has been designed to bridge the gap between traditional and digital book, delivering an immersive storytelling experience with vivid projection, sound effects and background music. The story library for Moonlite is growing with over 50 titles in the market, and we have plan to expand Moonlite globally in 2019. In Pre-School and Girls, the new PAW Patrol Ultimate Rescue theme in Season 5 is timed with the delivery of our fall product line that features some incredible vehicle. Early POS is very strong. Retailers are particularly excited about Marshall's Ultimate fire truck as the key driver for the holiday season. The delay of the new theme until closer to a fall selling season is also part of the reason we increased marketing spend in the first half of 2018. We did not refresh the theme in spring 2018, choosing to carry over the Sea Patrol theme we introduced in July 2017. We increased marketing in the first half to continue to grow the brand ahead of the new content and theme.The playset doll segment is one of the top-gaining category year-to-date according to NPD. We have 2 new exciting product lines that we developed internally through our brand innovation pipeline that fits within those subsegments. Twisty Petz is a cute line of collectible that transforms from adorable animals into bracelets with a simple twist. The early reads on this line are very positive. Toward the end of Q2, we launched Party Popteenies, the girls' collectible dolls product line we have been keeping under wraps. We created a fan music video featuring some popular YouTube personalities, and it already has over 5 million views.In Boy Action and High-tech Construction, POS reads for Tech Deck are high. Tech Deck is a cool boys' collectible grounded in authenticity. Skateboarding culture is cyclical in nature, and we're now in the upswing of this trend. We are excited about the upcoming launch of Boxer, a new tiny intelligent robot. In the constructive -- in the construction segment, we are working hard at reconnecting the consumer with the Erector brand name from Meccano product in the US. For fall, we have new licensed model including John Deere, Ducati and Ferrari.In the second half of 2018, in what is a slower selling season for Outdoor, we are taking time to focus on growing Swimways internationally. Despite the TRU situation, Outdoor still grew in the first half, and Aerobie in Europe is growing nicely. The product sign and packaging are being refocused for consumer outside of North America. We are continuing to carefully manage our entire business on a portfolio basis in line with our 36-months forward-looking brand innovation pipeline. We are especially focused on the need to drive diversified, balanced revenue growth as well as managed fixed and overall cost conservatively. We will provide further category performance update as we usually do in November. As part of our product development process, we also consider potential license opportunities that complement our core business. Content-based products, whether the content is internally generated or licensed from third party, remain important as the intersection between content, community and commerce grow stronger. On our previous call, we highlighted 2 of the exciting new licenses we have for 2019, Monster Jam and How to Train Your Dragon. Spin Master is a master toy partner for both franchises. We are currently working on these toy lines and look forward to sharing them with you at the 2019 toy fair in New York next February.Our second growth strategy is to significantly increase our international sales. Our established markets are performing well, with exceptional growth this quarter in Central and Eastern Europe, Germany, Australia and Mexico. In Germany, for example, the market was up low single digit, and we're up more than 14x that number. We remain, however, relatively underrepresented compared to the industry, with our overall market share being less than 1%. We are increasing digital marketing efforts in Europe significantly versus last year as this market continues to evolve toward digital in a similar way to the U.S. and Canada. In 2019, we will be selling directly in Russia, Switzerland, Austria and Greece. Russia is a multibillion toy market and growing rapidly. It is strategically important for us to be direct in this key global market. We will distribute directly in most of the territory centered in the Moscow-Saint Petersburg area starting in January 2019 and use third-party distributor for certain less populous regions. Switzerland is a high-income market of nearly 9 million people where the top 4 retailers control 80% of the marketplace. This plays well for Spin Master's strength. These new territories represent market penetration opportunities to increase our scale outside of North America, supporting our growth and margin expansion strategy. Remember that we achieved a meaningful margin pickup by selling direct at wholesale prices versus third-party distributor pricing. We launched in China in July 2017 with a core group of products, including PAW Patrol, Hatchimals, Bunchems and Sew Cool. According to Euromonitor, China is expected to overtake the U.S. as the largest toy market globally by 2021. PAW Patrol took its fifth award last week at the China Licensing Awards where PAW Patrol won best young property of the year. CCTV is continuing to be a strong partner in airing the PAW Patrol episodes free to air in China, with Season 3 launching this fall. We are expanding distribution in China in 2018 to include the Walmart department store and wholesale channels. In addition, we have opened a new flagship Spin Master store on Tmall, which, as you know, is the division of Alibaba and the largest retailer in China. We feel confident in our ability to grow in China, and we have been expanding our product offering to meet the consumer demand. Adding to the existing brand we have already launched will be Air Hogs Supernova, Luvabella, Party Popteenies and Kumi-maker for fall 2018. Spin Master has built a global reputation for product innovation, strong partnership and creative marketing. We now understand what work and what doesn't much better than just a few years ago, and that's contributing to the acceleration of our growth strategy. We believe in our ability to increase sales and establish market to a new channel of distribution and successful -- and successfully enter into new market. We're driving toward a medium-term goal of generating 40% of annual gross product sales internationally.Third, we continue to develop evergreen global entertainment properties. As Ronnen alluded to earlier, we are ramping up our effort to deliver short form and other entertainment content. This is part of our larger strategy to build and maintain franchise properties. We continue to work very hard in the coordination of the global toy and entertainment launch for Bakugan early in 2019 and for Abby Hatcher later in the year. Early retailer feedback is very encouraging.Fourth, we intend to grow through strategic acquisitions. We are looking for opportunities to acquire brands, fuse these newly acquired brands with our innovation capabilities and deliver growth in sales and margin by leveraging our global infrastructure. Our result exemplify how our acquisition strategy is working. We have the balance sheet and financial flexibility for acquisition, and we are actively seeking opportunities with the right strategic fit. Our most recent acquisition was Gund in April. The integration is going well, and we have just gone live on SAP. Gund has put us in a leadership position in the plush category. Our strategy is now to raise brand awareness globally and leverage Gund's expertise across our other brands.I want to conclude with a comment on our focus on cost management and driving productivity across the organization through value engineering and automation. As a management team, we have a continuous focus on driving incremental improvement across every aspect of our business. This constant focus fosters a strong result-driven culture that allows us to continue to execute on all our growth strategies. For example, we have spoken on past calls about the diversification of our supply base in Vietnam and Mexico. We have now established an office in Bangalore, India, and we are building a meaningful supplier base in place that will grow further over time. Overall, we are confident for the second half of 2018, but we still have a lot of work ahead of us to ensure that management and shareholders' expectations are met. We are looking forward to this and are very thankful for our great global team who continue to work hard to deliver for all of us.That concludes our formal remarks. Ronnen, Mark and I will now be pleased to answer your questions.Operator, please begin the question period.
[Operator Instructions] Our first question comes from the line of Adam Shine with National Bank Financial.
So good solid results, obviously, in a trying Q2 environment. Maybe for Mark, a few sort of housekeeping items. When we think about modeling, you've touched on some timing factors as related to lower-than-expected sales allowance line. I think we ultimately sort of bounced back within the normalized range as you alluded to, 10% to 12%. But on the other revenues front, which was particularly strong, you're tracking at $63 million first half of the year. Last year, you were $86 million for the year. Can you give us any color on that? And then I'll follow up with a few more, please.
So Adam, thanks. Other revenue is tracking strong. I don't think that it would be appropriate or wise to just extrapolate that out for the year on the same basis. Just keep in mind that other revenue is a combination of various elements, and a big chunk of what we're generating in other revenue now comes from licensing and merchandising programs which are actually managed by third parties [ on our cost ]. So we don't necessarily have that visibility to be able to actually provide formal guidance on that right now. And so as we bring more of that in-house and build our own in-house capability, which is something that Ronnen discussed on -- in his section, we'll kind of get more visibility on that. It is an important part of our business. It is accretive to margins. But what we've done is, from a guidance perspective, given you that gross product sales guidance as well as the adjusted EBITDA margin guidance, and I think you should focus on that. And as we get more kind of mature over time, we could think about giving a guidance on revenue but not at this point in time.
Okay, and just when we look at the line item, depreciation and amortization included in the cost of sales, it did double year-over-year and certainly a step-up from the Q1 level. Now some of that, I think you alluded to, relates to the nature of additional entertainment content. How should we think about that in coming quarters? Is that a new potential run rate? Or do we take a step down to more normalized levels?
I think you should, from a modeling perspective, think about D&A at around 3.5% of CapEx in terms of modeling, which is a little bit higher than we have actually modeled in the past -- we've given you guidance on in the past. But this quarter was a little bit unusual in the sense that we have a conservative accounting policy. If we actually make a delivery on a TV show in one territory, we actually amortize 100% of that episode's costs. And so I'm not going to get into the details of specific shows here, but we actually took 100% amortization on a certain delivery even though we actually didn't have revenue that matched it, and in future periods, you're going to then get that revenue coming in without any amortization so there's a little bit of a timing issue going on here.
Okay, great. And then, I guess, just in regards to the TRU liquidation dynamic. You touched on the fact that obviously, clearly, Q2 was impacted from a GPS basis. I don't know if you want to get into any specificity as to quantum. But you also highlighted the nature of some impact on margins. And maybe for Mark and/or even Ben, as we look into the back half of the year, do we see, for example, some of the pickup of sales from TRU and other retailers, but retailers potentially demanding above-normal price concessions? Is there obviously incremental spend related to heightened awareness of the toy product that didn't necessarily come from prior marketing spend on the part of Toys"R"Us specifically? Can you talk to that dynamic?
Yes. So in the quarter, you noticed that we actually had a kind of delusion on our gross margin for the second quarter. Part of which was driven by amortization which I described. A part of which was actually due to some closeout activity. We actually took the -- we took the opportunity in the quarter to clean up some inventory that we had in our warehouse and relating primarily to discontinued Star Wars lines and Flush Force, which didn't actually work very well. So we cleaned it out, and we took the gross margin hit in the quarter, which sets us up very well for the second half of the year. And as it relates to the other part of your question, Ben, do you want to...
Yes. So all the retailers are happy that the Toys"R"Us liquidation is over, and so that's the first statement to be clear on. But everyone is working on securing extra dollars and market share aggressively, so we're holding a lot of these meeting with all the retailers. And there's a lot of work ahead right now in Q3 and Q4 to ensure proper execution, not just on our behalf, but on behalf of the retailers to secure extra space in their stores, extra merchandising and also -- every retailer, I think, is formulating their own plan, which we obviously don't disclose publicly. But I think the retailers are very eager, and they see the opportunities to gain their unfair share of the Toys"R"Us business that was left. And again, we said before that we expect 80% to 90% of the Toys"R"Us volume to come back this year and more or less to be all back next year, and I think we're continuing to hold that these numbers are what we still believe in.
Our next question comes from the line of Sabahat Khan with RBC Capital Markets.
Just a follow-up there on the other retailer. I guess earlier in the year, I think, on some of the past quarters, you'd commented that something like 80% to 90% of the demand could be picked up by some of the other retailers. Can you maybe give an updated view on that now that you're past Q2? And kind of -- is the -- kind of the liquidation based on what you saw across the industry, is it kind of as you expected in terms of the broader industry inventory as well rather than your inventory with retailers?
Yes. So let me just -- in Q2, particularly in Q2, if we step up and look at the impact of Toys"R"Us on a global basis, the U.S., U.K. and France were the -- were impacted the deepest with Toys"R"Us where in Q2, for example, the overall market in the U.S. was -- the POS was down 1.7%, the U.K. was down 14%, France was down over 9%. We had pretty much anticipated all of this to happen as we discussed previously, but furthermore, I think despite all of these headwinds, our overall portfolio continues to do really well on a global basis. And for us, the Spin Master, our year-to-date POS is up approximately 20%, yet our retail inventory is down over 25%. So what this means is that we as a company have been incredibly prudent to ensuring that all of our product shipments were not overdone in Q2 when we wanted to make sure that we left Q2 in a very, very good ending retail inventory position in order to make sure that the shelves were not going to be clogged that would prevent the full shipment in Q3 and Q4 of our fall product line. So I think we've actually executed really well on this, and we feel that we are well positioned now after Toys"R"Us for the rest of the year. And we also feel that we've managed a situation pretty well, which will set us up as we wanted for the back half of the year.
I was going to say, on the entertainment content launches that you have planned for 2019, it seems like the Abby Hatcher show launch late next year so there might not be any toys for that. At what point in the year would you expect to launch toys for Bakugan? Would that be in conjunction with the entertainment content? Or would you wait a little while and it could be an H2 '19 event?
Yes. Thanks, Sabahat. Let me clear up on my opening remarks. Abby Hatcher is scheduled to be on Nickelodeons at the end of this year or very shortly in January of 2019, and the toys will be fall 2019. So they will hit some -- next calendar year. And for Bakugan, the toys are expected to be out in this first quarter of 2019, and the show will also launch in 2019.
All right, and then just one last one. I guess, as you think about some of the headlines that we're seeing around the trade disputes, how do you kind of feel your position in terms of some of your options to move production around to maybe other jurisdictions? And obviously, it's a broader industry headwind, but how are you guys thinking about planning for a downside risk there?
Yes, I think when we look at tariff, we obviously know the same as what everybody knows. The suggestion is it would be in 3 waves with some focus on the industrial goods, and I think consumer goods is in wave through -- is in wave 3. What it suggested, 10% tariff. Toys were not named into these consumer goods. Nonetheless, we're staying very close to it, but I think it's important to know that over the last several years, we've worked very hard to diversify our supply chain from just Southeast China. So we opened our Mexican sourcing office in 2015. In 2017, we opened our Vietnamese office. Just a few months ago, we opened our -- an office in India as I just mentioned. So we remain very, very focused on diversifying our supply chain. And today -- for today, what that would mean based on the international mix and the prominence of the good, it would be approximately maybe 3% impact on our product, if we did absolutely nothing, which, of course, the management of this company would be very focused in finding ways to offset it with the different tools that we'd have at our disposition.
Just to clarify, that's 3% increase in COGS maybe? Is that what you mean by...
So let me just walk you through some of the numbers behind what Ben said. Right now, 75% of our production is in China. 25% is outside China. And so if you actually take that 75% relative to what would actually land up in the U.S., then we think it would have an impact of around 3% to 4% on COGS. And we'd find a way to either pass that through or through productivity programs, make sure we offset that. So we do not think that the impact on tariffs is going to be significant to us. Although, obviously, we do not want it to happen overall. It wouldn't be a good thing.
Our next question comes from the line of Kenric Tyghe with Raymond James.
Ben, just with respect to the buzz on PAW Patrol and holding back, so to speak, on Ultimate fire truck, would it be a fair characterization to say that it was as much strategic and holding it back to get that buzz amplified but also an opportunity, given the Toys"R"Us disruption for retailers and retail partners to clear out or maximize value on in-channel inventory? And was there any a -- sort of a twofold play there that seems to have worked rather well?
Yes -- no, I think you -- Kenric, your statement is 100% accurate. Is -- PAW Patrol -- when we look at the at the first half of the year, our global POS is still up in the low single digit. And as I mentioned earlier, we've seen the POS accelerate in July as soon as the TRU shutdown was completed. We've also just launched the new season, The Ultimate Rescue. And the first episode that we just broadcasted, it gave us the best rating so far this year. Ronnen also mentioned new content direct-to-video special on around the mighty pups that's coming for the fall. So we're very happy with the quality of the content coming in the market now, the new content. And we're -- we feel that we're in a very strong position at retail to ship our new theme vehicle based on how we managed the transition in the market with Toys"R"Us. And I think it's also -- the one last point I like to make is, it's just important to remind everyone that at any given quarter, we could always ship more PAW Patrol, but we take a long-term view on managing the franchise. And we always do for what is right for the long-term health of the franchise. And despite the fact that, even in the first half, the POS was positive, we really, really wanted to make sure that we left Q2 with the Toys"R"Us liquidation in as good as of a position for then the new theme to be launched and merchandised and marketed properly in the marketplace around the world.
Great, and just a quick follow-up. Would you characterize the buzz around the Ultimate fire truck in this next season as equivalent to a better than the life-size tower, which was the anchor sort of product in the back half of last year?
It's yet to be determined. I think that's -- I mean, the tower is such an iconic toy to the show. It's the foundation of PAW Patrol. But I think the amazing thing about the Ultimate Rescue, and I encourage all you guys to start watching the episodes, is just how amped up the vehicles are. And it's not just the fire truck, okay, it's the police truck, and it's Skye's helicopter, and it's Rocky's truck. And they're all the Ultimate vehicles, and they're all going on these amazing rescues together. And the show and the story is just amped up. So I think it offers a new way for kids to play that's complementary to the tower. I don't think one takes away from the other one. And I think the really exciting thing is that we are doing this special 1-hour movie on Nickelodeon with the specific product line attached to it. We've never done that before, and around the Mighty Pups which is also an amazing strong theme. And I think that that's going to really resonate with kids. And I think the really important thing to know is just that -- we're not just creating 52 new episodes every single year. We're trying different things, and we're being very bold, okay, with the franchise and having the franchise be innovative. We're an innovative-led company, and so we're innovating with them the way we're doing television for kids, trying different things that have never been done before and creating our own playbook and not following other peoples' playbooks from the past. And I think that really will resonate with the consumers and actually grow the marketplace in the future.
Our next question comes from the line of Gerrick Johnson with BMO Capital Markets.
Just wanted to make sure I heard you right on POS, the 20% growth you're talking about, that's first half. And is that inclusive or exclusive of the Toys"R"Us liquidation sales?
It is inclusive, Gerrick.
Okay, and the time of inventory, the same thing?
Yes, it's correct.
Okay, do you have a number -- a POS number excluding Toys"R"Us?
No, we do not, but Gerrick, what is so interesting when you look at the POS is that, as you know, POS is measured in dollars. So when you look at the POS in the overall marketplace given the deep discount, there is actually -- we've lost -- the market has lost a lot of dollars. The market has gained dollars because Toys"R"Us liquidated, and then they had a -- the pricing -- the deep discount on pricing obviously drove some POS. Yes, the POS was as a pretty deep discount, so I think it's extremely difficult to model the exact impact in the marketplace.
Okay. And again, just to clarify, you're measuring POS at retail dollars as opposed to wholesale dollars like Hasbro and Mattel do, right?
Correct.
Okay, cool. And on the other revenue, how much did the change in accounting on apps affect that? I assume not a whole lot, but if you could tell us how much that was effective.
There was no change. Just to be clear, Gerrick, we've always had a relatively conservative accounting policy, which is a policy that I just described. So as soon as we deliver one episode anywhere in the world, we take the full amortization of the cost of that episode. So that we applied. It wasn't -- I'm not going to break it out exactly, but it was a few million dollars that actually impacted us in the quarter for that particular line.
Okay, and so that's the apps. There's a couple of million bucks from going to...
No, sorry. Are you talking about the apps or you're talking about the amortization? I'm sorry.
I'm talking about the app revenue going from...
Sorry, we don't actually break out the app revenue. We don't break out app revenue. It's part of other revenue.
Okay, I was just asking because you did it on the first quarter. You told us what that growth was inclusive and exclusive of that app accounting change.
No, sorry. Yes, I was actually confused. The change in accounting policy did actually refer to apps. And so the impact, I think, was about 20 basis points, I think, in -- on gross margin if you look at -- yes, if you actually take away the IFRS 15 change, the year-to-date gross margin impact was about 20 basis points less. So our gross margin would have gone down 1.7% instead of 1.9% in the absence of that accounting change. I think that's what you're asking. I apologize.
Yes, and I was asking how much it affected the other revenue but we can move on. It's only going to be a couple of million bucks. Were there any other shifts in other revenue. You have right-to-use and right-to-access licenses? And so I'm wondering if there was a right-to-use you sort of bumped in, in the quarter?
No, there were no other impacts to other revenue, Gerrick, on that front.
Our next question comes from the line of Brian Morrison with TD Securities.
Mark, just on the capital intensity, is that 3.5% both this year and in 2019?
That 3.5% that I referred to was the depreciation and amortization component of the -- relative to CapEx. So just remember, Brian, the guidance we're giving you is that CapEx typically runs at around 5% of sales. The depreciation and amortization runs at around 3%. For this year, I'm suggesting that we go to 3.5%. And the CapEx, including our King Street, would probably be closer to around 6%.
Sorry, I meant the D&A. I apologize. But that's 3.5% for '18 and '19?
Yes, correct. Because we're building more entertainment franchises, so I think the D&A is going to tick up a little bit. So I think 3.5% for your model is more reasonable.
Yes, that's fair. And just on the acquisition scene, maybe for Ben, are you seeing increased opportunities with suppliers so they're potentially captive to TRU? And just from a high level, are there any other opportunities of magnitude?
I think -- I'm not sure that we're seeing an increase in activity yet. I think that will take a few more months and quarters to work its way through as everything settles. We continue that -- always be in discussion with several companies, and we were always very active in the -- in this area of the business, but nonetheless, I'm not sure that we have seen an uptick just yet.
Okay, and then final question. Just -- can you just discuss or rank the channels as you see replacing TRU, be it mass or online alternative? I just want to understand where e-com is? I think you said 22% industry and yourselves recently. Where do you think it's going? And could that increase as forthcoming potentially require any investment in your distribution capabilities?
So -- I think with -- I think the e-commerce today -- I mean, last year was approximately 27%. We think it'll grow some this year probably -- probably get close to 30% this year. So I think e-commerce will continue to gain some market share, and I think a lot of the rest, Brian, will most likely redistribute itself in the marketplace almost in the proportion that you see where the channels are today. So I think high level, that's probably the way we would model everything. From us to need to make some incremental investment and distribution, we believe that we -- actually, if you remember last year, we've already done a lot of investment in our go-to-market capabilities. And they're already bearing a lot of fruits from an operational standpoint. We feel like we're properly positioned for the future, and with that said internally, we continuously always reassess and look at reallocating talent to our e-commerce and the different part of the business that we see strategic going forward.
Okay. And our next question comes from the line of Steph Wissink with Jefferies.
Hopefully, this'll be a quick one, but I'm wondering, Ben, if you can talk about your portfolio of brands as you think about other revenue in licensed and entertainment. How are you tapping your total portfolio versus just some of your lead brands? And how should we think about that contributing over the next maybe 1 to 2 years?
Well, I think, Stephanie, and I'm going to let Ronnen chime in as well because he's incredibly passionate about this too. But I think the way we look at -- when we look at our 36-month brand innovation pipeline, we -- I think everyone's familiar with our process so we're still very, very rigorous in not just developing great innovation for each one of our key segment, but also we believe that storytelling and entertainment is becoming a more and more important part of the global marketplace. And we're also very focused on continuing to create different franchises that will allow for these incremental revenue stream to come to life.
Yes, I think that we spent a lot of time talking about Hatchimals and talking about PAW Patrol, and I'm so happy that you asked this question because we're seeing very good momentum in the Games & Puzzles area of the business and in Activities. And those teams are putting out super innovative products. The Games and Puzzles part of the business is expanding in Europe. Our acquisition of Cardinal internationally is really kicking in. So we see a really good momentum for the balance of the year and going into '19. And there's new product launches that are going to happen this year like the Twisty Petz, which is seeing some very, very, very strong sales and uptake with the kids, which will lead into 2019. And then the new franchises, we've been working on Bakugan now for close to 36 months. We waited a full 7 years for a fresh generation of kids. We waited really patiently to relaunch that and gave it a lot of thought and bringing new innovation, something fresh and new; building on the existing magical essence of what Bakugan is all about; and bring the television show to the market that is relevant and in keeping with the way kids watch TV in 2019. So we're very excited for that to come into the market in the first quarter of next year and very focused on Bakugan. And then, again, with that Abby Hatcher, I mean, I think that I probably could've had 4 kids in the time that it took to make Abby Hatcher, not myself, but maybe my girlfriend. But anyways, it's been 4 years in the making, and I'm very proud of the focus that the entertainment team and the company as a whole has taken to bring something to market that we think is going to be non-derivative and stand out and be something that is very different from what is in the marketplace today and that's going to resonate with kids. So very excited to see that air on Nickelodeon, and the toy line looks amazing. So bring freshness into our franchises, it's super important. And very excited for you guys to start to see the fall 2019 line where -- I'm not going to mention on the call, but there's a lot of other initiatives in boys and there's a lot of initiatives in girls that are complementary, that are more toy-based, that potentially also have the long-term potential to be turned into franchises like Hatchimals. And we're very focused on that and complementing that with short-form content and really leveraging the in-house capabilities that we have from the entertainment team in delivering story-based content and how to bring characters to life to kids. So looking forward to -- for you guys to see what's in the pipeline.
Okay, now we'll end the call. Thank you for participating, and we look forward to speaking with you next quarter.
Thank you.
Thank you. Bye-bye.
This concludes today's conference call. You may now disconnect.